Unfortunately, the college application and search landscape has its share of scams and deception. Perhaps because most consumers (students & parents) enter degree programs at most a few times, they are less familiar with the higher education system than with something they purchase over and over and where they build experience. Examples of deception range from colleges pressing students to enroll in near-worthless degree programs to college rankings based on questionable surveys and data. There’s a lot of it. Today we’ll cover one particularly insidious scam: the sale of universal life insurance to “save” families money.
The basic idea is that, because insurance policy cash balances are assets that are ignored in the FAFSA filings, shifting your savings into these investment categories can lower your Expected Family Contribution(EFC)/Student Aid Index (SAI) and allow you to qualify for more need-based aid. While this may work for a very small minority of college students, it doesn’t apply in the large majority of cases. What makes this idea even more useless is that the College Board’s CSS Profile filing – which is used by the selective colleges who award a great deal of aid and have significant resources – does require reporting of insurance cash values.
Most college students’ EFC is too high to make any difference in how much they pay for college. Many middle-class families have EFCs in the $50-80k range. And the majority of college students attend public universities, mostly in their own state. What happens if a family shifts its assets into a universal life insurance and successfully lowers their EFC by say $15,000, from $65,000 to $50,000 and then enrolls in their home state public university? (Mind you, this would be a very successful EFC reduction effort, requiring the shifting of hundreds of thousands of dollars into a universal life insurance vehicle.) What happens? Precisely nothing. The home state university has an official Cost of Attendance much lower than that $50,000. The student remains ineligible for need-based aid. The family saves no money.
Interested in going to a private college? Most private colleges today award generous amounts of merit aid to entice students to enroll. Is this merit aid dependent on financial aid filings and the EFC? Nope. It is independent. And the well-endowed private colleges that can fill full need – a decreasing portion of the higher ed environment, unfortunately – are exceedingly difficult to get into and assess financial need using the CSS Profile, which requires reporting of insurance cash values, and their own proprietary formulas, which are secret and are difficult to game.
In general, EFC optimization tips are ok when they are very simple – an example would be paying down a home equity loan when you have significant cash sitting in a checking account - but anytime they become complicated and require purchases in investment vehicles, the trade-offs need to be carefully evaluated and are unlikely to be productive.
Some could argue about insurance: “well, what’s the harm?” The harm is that investing costs money and universal life is an exceptional opaque investment that has been criticized widely among investment professionals for its high amount of hidden costs and unjustifiable commissions.
As a basis for comparison, what is the impact of having parent savings in brokerage or bank accounts, which are assessed by FAFSA and the CSS? How much are you theoretically saving? The precise answer is 5.6%. That’s not a high amount. That means that, over the course of a 4-year undergraduate career, your assets add 22.4% to your EFC as a whole.
Universal life insurance policies typically combine a life insurance with an investment, often an indexed broad stock market fund or a money market fund. But these universal life policies arrive loaded with management and sales fees, unlike many modern low-fee investment products. And many policies lock you in for a number of years with high “surrender” charges. Will an insurance policy held for a number of years exceed that 22.4% you may (probably not) have saved on college? Very likely. “One insurer charges upwards of 8% of the premiums and cash value in the policy in the first year alone, according to Steven Roth, president of Wealth Management International, an insurance analyst and litigation consultant.” And here's another independent advisor criticizing universal life with some refreshing clarity describing what insurance should be (spoiler: it should insure you against catastrophic events). Another critique: a warning in Forbes magazine from 2014, titled “Consumers Beware.” That’s why universal life schemes are worse than useless. They actively harm your financial health.
In a world where you can easily buy an equity index fund from Vanguard or another financial services provider and pay a total of 0.05% per year with no added fees, why would you invest in the stock market through some complex insurance scheme with much higher fees? The same sort of low-expense investment options are also available for money market funds and fixed-income investments, the result of technological developments and aggressive competition in the financial services industry. We’ll stress that we are not providing investment advice, merely commenting on how it relates to college costs, so if someone advises you or one of your clients to purchase such insurance with an eye towards college costs, we urge you to: review it with an impartial third-party independent financial professional to make sure you understand the proposal before buying anything and make sure you understand what it’s impact would be on your EFC/SAI.
Find more information at the CTAS site. CTAS provides data, reports and personalized assistance with college pricing and aid appeals.